I was recently on a NYSSA (New York Society of Security Analysts) panel to discuss systemic risk with the Vice-Chair of the world’s largest asset manager and specialists from the US treasury and the center for financial stability. Here is my presentation putting the 2007-2009 credit crisis into a 400 yr historical perspective.
Archive for category Finance
Warning! this post is going to be technical and deep in nature. To ward off casual readers, I am inserting this image of E8 to the right which may or may not satisfy your need for supersymmetry and a TEO.
Firstly lets discuss value and representations of it. Money is a representation of perceived value. Representing societies perceived value of things correctly is integral to economic development. Value perception in the form of price or expected price is what allows for decision making and choice. It is the operand enabling economic operations by actors.
Representative value using a token allows for virtual ownership. Separating a thing from its representation allows you to sell a house, car or security without having to physically possess it at all times as a squatter. You transfer a title or property right and the thing is then recognized socially as owned by someone else based on that representation. Without titles and representative rights, every time you left your house or car, someone else could possess.
The social invention of value representation using tablets or paper is why capitalism work in the west according to Hernando de Soto.
So abstracting a things ownership attribute via representation using socially agreed to information structures such as titles using centralized public property registries was powerful and a key to economic development. Think about the Joint-stock company as an example of this. Patents do this for ideas, and bonds for future cash flow streams. Even claims to skills are vital for trust. A persons ability to be a doctor or engineer is predicated upon a social claim to expertise in the form of a license, which is an earned asset. Registered, recorded representation prevents or limits theft by occupation, falsification or physical coercion etc. It enables future claims to cash flows, lending and investment.
The mechanism of Socio-economic value representation and assignment enables the economic macro-process choices for spending and investment. The choice to swap representations of money, assets claims (property) etc. are maintained by code (legal code) with lawyers and judges acting as societies processors. Legislators and technocrats are cast in the role as developers of the code and regulations. Due to corruption or ineptitude, a lot of the property assignment and representation can’t or doesn’t occur properly in poorer countries. This property is then outside the formal system leading to the inability to resolve super-ordinate problems like soft and hard utility infrastructure like waters, sewers, schools and fire departments. Many squatters interviewed in the emerging world would gladly pay taxes in exchange for the security of ownership and infrastructure that property claims would represent a claim to support and receive.
According to economist de Soto, the value of property that is economically dead capital or lost value due to improper or unavailable rights registration is $9.3 trillion (yes that is trillion). Most of this $9.3 trillion property or dead capital lies among the poorest people in the world. This link shows a map of latin american dead capital by country. This dead capital to poverty relationship is likely causal and not just correlate; ask the World Bank or read de Soto’s book, they get this. Think about trying to sell your house or car without a title, the claim uncertainty would reduce its claimable value to the buyer. Having only squatter’s rights significantly impacts its sale price. Buyer’s don’t know who is going to show up and make a claim. That discount due to uncertain claim is dead capital. The property is there but trust in its ownership is missing. Bad actors and mafia become the informal mechanism for claims production, further sapping the wealth from poor, but unregistered property owners.
Bitcoin, like money is misunderstood by 99% of the people using it. Money is a social protocol with each us accepting its various forms or APIs, be they Dollars of Dhirams. People organized as cultures agree to pick various objects, bits etc. and ascribe representations of value to them. Value is perception. Most monies average a 27 year life before the dream dies, usually due to a captive central banks forced on an unhealthy diet of government debt which has become unserviceable.
An economy is an adaptive social process not a strictly linear physical phenomena like a machine. Organization and trust among groups winning over corruption and deceit allows for the rule of law, capital, knowledge and most importantly human development. Its all in my book which took 4 years to write. FYI author’s make about $2-3 a book and economics books sell 2-5,000 copies on a good run . I am shilling for the sake of your knowledge, more than my pocketbook. So how do bitcoin and ethereum etc. enter in to this? Aren’t they just digital cowrie shells or beads?
Bitcoin is a technical protocol that happens to be expressed as a blockchain ledger, wallets and services that are then expressed and mostly understood as the social protocol collectively known as money. So here is where Ethereum and Bitcoin become interesting as form of money. Money as a believed representation of value is valuable to an economy. Registered property minimizes corruption, allows property rights, mortgages, capital formation etc. The integrity and ease of access to the legally and publicly recognized representations of property are what can help free up the $9.3 trillion in global dead capital.
Costly bureaucracy, ignorance, illiteracy and politics limit many from receiving and being able to use the legally recognized representative claims to their property. This forces them to be squatters or operate in the informal economy which is actually costlier and less safe etc. again read de Soto to understand this. If you are from a rich world country it is tough to understand that these choices are sub-optimal but rational for local economic actors who are dis-enfranchised often by design from the formal property system. Formalizing property and title, brings it in from the black market allowing for legal protections such as company formation, lease-holding, utility connections, political voice, capital accumulation, financing and legal standing and yes taxation. So where does the Ethereum and Bitcoin stuff coming in?
Bitcoin currently has a market cap of $10 billion. In global economic’s terms it doesn’t count for much. It may one day, but $10 billion doesn’t swing the needle in a forex market that trades $4 trillion a day (hint bitcoin trades $30-50million a day as of Feb 2014). The protocol for bitcoin, alt-coins and Ethereum may one day be profoundly interesting.
Full disclosure, I volunteer as a spokesperson for www.solarcoin.org which uses a representation of energy based on this paper to stimulate solar energy production for the next 40 years. SolarCoin may use Ethereum for grant representation if it makes technical sense to the SolarCoin community.
The Blockchain concept is where things get interesting. The Bitcoin blockchain is by design a distributed (there is no center) data structure that maintains an almost inviolable record of each transaction that passes into it. When a message is added to that transaction its a record, like a public land registry etc. Anything can be recorded in the Blockchain by associating a transaction message to some trusted meta data. Thats pretty cool computationally and philosophically. The blockchain is a bit like a platonic growing symbolic structure. Instead of representing $10 billion in bitcoins as it does today, the bitcoin blockchain could be the key to represent trillions in property, like home titles or securities transactions (look out Northern Trust $5 trillion and State Street $5 trillion in assets). Who needs a custodian to track ownership when the blockchain may do it cheaper and safer?
Ethereum is the next level. The current blockchain is effectively a huge database structure with no center and very limited ability to falsify previous records. Computationally that is very cool but kind of like an unbreakable clay tablet. What is now pejoratively called the cloud isn’t a cloud at all, its actually the clod. There is a clod of servers here and there owned by various people and groups (amazon, google, NSA (handling your personal back-ups), etc.). The blockchain is the first real cloud computing transaction structure. bit Torrent was static transfer, but a fleeting record. The true cloud of data in a blockchain is a place where the additive database (think of it as having millions of tiny records) is everywhere. For the physicists and math geeks reading along bit-torrent structures could be considered to have lower symmetry over time than the clod. To the data consumer the data and its history of a blockchain looks the same from everywhere to everyone. It is persistent and identical from many directions and sources. The data has become the protocol. Use the bitcoin protocol and the data is maintained.
So here comes the next super cool step. Ethereum represents the first attempt at persistent omnipresent computation and state maintenance. Ethereum takes the blockchain data structure with its data user symmetry and integrity and pops a Turing complete language and process capability inside. Wow! Welcome to the machine. Suddenly one has the ability to create a machine or computational functions that are at once inviolable (to a degree) and highly symmetric.
The protocol is the processor. Now that is pretty amazing, it won’t get you out of that nasty Goedel problem, but… The ability to complete and compute in trusted fashion with an omni-present 3rd party to act as escrow etc. agent.(pun intended) is deeply profound. If you are a clod vendor like Amazon, IBM, Microsoft, database vendor or escrow agent dealing with symbolic representations or certificates of value look out. Ethereum and its ilk could eat your current lunch in the same way the TCP-IP protocol ate so many industries with layer of firms built on top of it.
Optional geek paragraph ahead, on the physics of information and evolution of energy processing:
If you understand the data symmetry concept you will get the E8 reference earlier and appreciate the Wheeler reference about a digital universe resolving itself across energy and structural gradients as it from bit. Wolfram’s alpha may end up living in Ethereum resolving itself. Ethereum indeed! It may end up having the highest phi(m) in the known universe. Have to ask Eric j. Chaisson about that.
My publisher has advised me that, The Nature of Value is to be released in July 2014.
Synopsis and sign-up here:
Why do some investments and companies grow as others wither and die? Why did the internet bubble burst just like the railroad and radio bubbles before it? How does the money belief system work? Can a value investor really learn from nature? Why does traditional economic thinking get things so wrong?
The economy is an adaptive selective information process that works just like nature. The story of this process can help investors and managers understand innovation, competitive advantage and the keys to value creation.
Economic behaviors and outcomes explained using simple examples to provide fresh insight into how things work. The Nature of Value, explains how value gets created, lives and dies by combining human behavior and nature’s processes.
Whether you are an experienced value investor, new to investing or just interested in the latest thinking in economics, The Nature of Value is likely a fascinating and potentially profitable read.
The Power of Gold by Peter L. Bernstein is a great read for its scholarly research and Bernstein’s understanding of monetary theory. The book gets interesting as Bernstein explains that one of the reasons gold functions as money so well is that it is inherently useless. Money plays three economic roles, means of exchange, store of value and unit of account. Value is subjective and so the endless pursuit of a store value is a mirage which Bernstein explores as a narrative across thousands of years. Bernstein does a great job explaining how the US left the Gold standard and what that meant for monetary policy as a means of explaining how money works.
I won’t go into monetary theory in-depth in this post, but the need for a depreciable currency becomes quite evident as Bernstein highlights the suffering caused by severe deflations instilled via high interest rates put in place to attract gold to maintain issued currency gold parity in earlier times.
The late Bernstein had a rich background including roles at the FED during many critical times. The role that gold plays in the necessary money illusion is highlighted here and Bernstein correctly hints at the requirements for monetary regimes to be as malleable as the metal without fixed ratios in order to minimize deflation based debt crises. The monetary component for maximizing economic growth is to maintain the money illusion with minimal value loss (inflation) and minimal volatility for extended periods.
As a sometimes teacher and perpetual student, I have a great respect for the ability to communicate clearly. The Cartoon Introduction to Economics is fantastic for this. It is like a comic book version of the Dummies Guide to series. The cartoon series of books includes micro and macro economics, statistics , calculus and physics with a clear and clean method. The graphic novel approach forces jargon reduction and clear communication. As an economics geek, I finished this in an hour, but found it a great way to brush up on familiar concepts. It also provided some novel ways of showing and explaining concepts to others.
If knowledge is the light banishing ignorance to darkness, then the Cartoon introduction series shines brightly opening many fields to offer knowledge for people who may be intimidated. I sincerely hope the author and publisher extend this series. As the saying goes, if you think education is expensive, try ignorance.
The U.S. dollar bestrides the world. Acceptable in every country, fervently desired in most, it is a potent symbol of American economic strength and power. But it was not always so. Indeed, it was less than a hundred years ago that the U.S. Congress established the Federal Reserve Bank, the American equivalent of the Bank of England or European Central Bank.
For most of America’s history from the English colonies established on the seaboard fringe of the continent over four hundred years ago to the early twentieth century, a wide and at times bizarre range of different types of money circulated within the United States itself. The monopoly of the dollar there is a comparatively recent event. The U.S. republic was established in 1783, but as late as the mid-nineteenth century, a tremendous array of different types of money circulated in America, with states and banks being free to issue their own notes. As late as 1860, there were some 9,000 different kinds of privately issued dollar bills circulating, around a third of which were counterfeit. On no less than six occasions in the first half of the nineteenth century, Congress passed acts allowing foreign coins-French, Spanish, British to circulate as legal tender.
Two attempts to establish a U.S. central bank, of the kind with which we are all now familiar, failed. Prosaically called the First and Second Banks of the United States, both had short lives, which ended by 1840. America then waited until 1907 (sic 1913) before the Federal Reserve Bank, with us today, was established.
Studying history is vital to keeping things in perspective. Big shocks etc. come around all the time and various capital flows, political responses and fiscal and monetary policy responses can’t be predicted but may be guessed at based on historical precedents. Fiscal and monetary policy from the 1950’s to 1980’s provides an interesting look at how things change while staying the same. The oil shock is highlighted below.
I just finished reading Paul Volcker and Toyoo Gyohten’s 1992 book, Changing Fortunes which gives first hand accounts of US and Japanese monetary policy with the regime ups and downs from the post World War II era to 1991. The book is based on a series of lectures and reads like a long narrative. The amazing thing one finds while reading it is how capricious seeming policy can be.
The appendix provides a chronology of events. The 1973 OPEC price shock can truly be called a Black Swan. The events unfold in 1973 in the following way: (from the book)
1973: Oct 6. Yom Kippur war
1973: Oct 16. OPEC raises the price of crude oil 70% from $3.01/bbl to $5.12/bbl. [my comment (The equivelant in late sept 2012 would be going from $92.06/bbl to $156.50/bbl.)]
1973: Oct 20. OPEC imposes an oil emabargo on the United States, and later the Netherlands. Oil companies shuffle shipments to ensure steady supplies.
1973: Nov. 12. Central bank governors, meeting in Basel, terminate the two-tier gold agreement.
1973: Dec. 23. The oil price is raised again, nearly quadrupling from its level of early October, to $11.65 a barrel. [my comment (The equivelant from late sep 2012 base would be a Dec. price of $356.07]
Now that is sticker shock. Amazingly US inflation using govt. CPI figures reported increases of only 8.86% in 1973, 12.09% in 1974 and 7.05% in 1975. GDP is reported to have only fallen 3.9% during the recession.
And for fun here is Nixon in 1971 spinning the dollars decline and blaming”international money speculators” instead of poor fiscal policy while jumping off the gold standard. Reading Volcker’s book is a great inside lesson about the machine.